The rational agent problem

My cousin Paul, who is definitely one of those really smart people you only meet once in a while, sent me a post from the Bloomberg website discussing the rational agent model in economics: Why Economists Have Trouble With Bubbles. It's a short read and explains some of the reasons why behavioral economics is becoming increasingly prevalent and influential.

I have always had major issues with the rational agent model. I don’t know much about economics or markets or the effects of natural selection on species, but it seems to me that individual choices often indicate irrationality (especially my own), while larger data sets seem to indicate some sort of rationality. By larger data sets I mean the collection or sum of individual behaviors for a given group. An apocryphal example is that of estimating the number of jelly beans in a jar. A single individual guessing the number of beans will tend not to get the correct number, whereas the averaging out of the guesses from a group of people trying to estimate the number of beans will be relatively close. Others argue that the market is rational while individuals are not. Without some form of rational decision making, economies would constantly and consistently fail, species would die off, and there would be little individual success. Then again, humans haven’t been around long enough to make my point statistically valid.

It is possible that this is a variance issue. We talk of people acting rationally, as if they always make rational decisions, and we even describe people as being rational thinkers. But wouldn't this be an example of the fundamental attribution error? Even more importantly, there is an underlying assumption that a person is a consistent model of behavior. I will argue that people are contextually rational, and that like everything else that matters, we need to be sensitive to variability.

More on this later.

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